the price of beans went up, so people started buying more beans
Could this ever be true? Is there a logical economic justification for this?
Discuss with your neighbour… we will vote
How do you derive an individual’s demand curve from her utility function?
What properties do demand curves have?
Understand the following concepts/outcomes (& how to derive them):
Substitution and income effects (of a price change)
Goods that are ‘substitutes’ or ‘complements’ (WARNING!)
Consumer surplus (from a transaction)
The lump-sum principle (and the distortion of taxation)
Understand the concepts:
Price elasticity (of market demand for a product), and what it means to firms’ pricing strategy
Income elasticity (…)
Cross-price elasticity (between two products)
Understand real-world issues:
A ‘Fixed-basket’ consumer price index (CPI) may overstate inflation
The lump-sum principle, the distortion of taxation
Fundamental concepts, useful for business & policy:
Goods may be ‘substitutes’ or ‘complements’ for one another (not the same as ‘perfect’ substitutes/complements!)
How can we consider/compute the Consumer surplus from a transaction?
\[Quantity \: of \: X \: demanded = d_x(P_X, P_Y, I; preferences)\]
\(d_X(P_X,P_Y,I)\) is homogenous in its arguments
E.g., \(P_X X + P_Y Y = I\) is the same as \(2P_X X + 2P_Y Y = 2I\)
\[d_x(P_X, P_Y, \mathbf{I}; preferences)\]
\[d_x(P_X, P_Y, \mathbf{I}; preferences)\]
Inferior good
Inferior good
Move to PPT here … “Changes in Income: A Normal Good”
\[d_x(\mathbf{P_X}, P_Y, I; preferences)\]
\[d_x(\mathbf{P_X}, P_Y, I; preferences)\]
Precisely: effect on the lowest-cost bundle yielding this utility
income and substitution effects
(ppt here… “Change in a good’s price”)
Thus
Read on your own, know:
Perfect complements: No substitution effect, only an income effect of a price change
Perfect substitutes: Large substitution effect – price change may cause a complete switch
In between: depends on curvature of indifference curve
Hands up please (or turningpoint if we’ve time: A=no, B-yes). If you could not resell or gift it…
Would you pay:
If your income was 100,000, would you pay
Would you pay:
Back to your current income .. what if all other smartphones cost 2000?
Would you pay for the Iphone 11pro:
Would you pay:
What do these things have in common?
What explains this?
\[Quantity \: of \: x \: demanded = d_x(p_x, p_y, I; preferences)\]
Previous lecture: What the constrained util-max implied for…
‘Homogeneity of degree zero’ of \(d_x(p_x, p_y, I)\)
How \(d_x\) responds to \(I\) (remember: inferior & normal goods)
How \(d_x\) responds to \(P_x\) (rem: normal or Giffen)
Util-max s.t. constraints \(\rightarrow\)
Understand real-world issues:
‘Fixed-basket’ CPI may overstate inflation
Lump-sum principle, distortion of taxation
Fundamental concepts, useful for business & policy:
Goods that are ‘substitutes’ or ‘complements’
Consumer surplus (from a transaction)
…
Derive
Individual’s demand curve from her utility function
Market demand curve
A very important number: Used for monetary policy and for targeting many salaries and benefits
Based on a ‘typical market basket’
A good example, 1982 vs 2012:
\[b_{82}=p^x_{82}x_{82}+p^y_{82}y_{82}\] \[b_{12}=p^x_{12}x_{82}+p^y_{12}y_{82}\] \[cpi_{12}=\frac{b_{12}}{b_{82}}\]
Have you seen this?
What is going on here?
FT Comment: New rule may even reduce the tax take
Suppose I am willing to sell a widget I manufacture for £10 and that you are willing to spend £11 to own it. Then we will do business and I will receive a consumer surplus of £1. Now suppose the government imposes a 20 per cent sales tax, and the price I charge for widgets increases to £12. Since £11 is your maximum price, you won’t buy it and the £1 of consumer surplus you would have gained is lost.
This is how tax avoidance imposes a so-called deadweight cost on society. People avoid doing valuable things that they would have done if not for the tax.
Read on your own, know:
Potential inefficiency of in-kind programmes and subsidies (App 3.3)
These ‘cross-price effects’ include both *substitution and
Warning: \(\neq\) ‘perfect’ complements/substitutes
\[d_x(p_x,p_y,I; \: preferences)\]
‘Map it out’: increase \(p_x\) \(\rightarrow\)
budget constraint shifts inwards \(\rightarrow\)
What might cause an individual’s demand curve for a product to shift (inward or outward)?
Yes:
My wtp for ‘right to consume good at its current price’ (rather than not at all)
Sum individual quantities demanded (at a given price)
Market demand curve: Relationship between total quantity demanded of a good and its price, ceteris paribus.
Sum the individual demand curves ‘horizontally’ … quantities demanded at each price
Similar things that cause individual demand curve shifts:
A random example:
Which is ‘larger’?:
change in \(q_d\) of oranges when \(p_{orange}\) rises or
the change in \(q_d\) of apple juice when its price rises?
Difficulty: Measured in different units, p and q have different starting values!
the measure of the % change in one variable brought about by a 1% change in another variable.
If a 5% fall in the price of oranges typically results in a 10% increase in quantity bought
we might say that ‘each percent fall in the price of oranges leads to an increase in sales of about 2 percent’
i.e., the ‘elasticity’ of orange sales wrt price is about 2 . . .
But elasticities need not be constant; they may depend on starting point
E.g., linear demand \(\rightarrow\) different price elasticity at each point
Price elasticity of demand: \[e_{Q_d,p} = \frac{percent \ change \ in \ Q_d}{percent \ change \ in \ p} \] \[ = \frac{\Delta Q_d}{Q_d}/\frac{\Delta p}{p}\]
(actually, the limit of this as these changes converge to zero)
Should always be negative (except for Giffen goods)
A unitless measure related to the slope of the demand curve
Very important for price-setting firms (more on this later)
India’s Hike Messenger takes aim at WhatsApp
‘Reliance ended up showing that there is elasticity in the market. If you drop prices, people will come on board,’ he said.
Next to add more space despite retail sales ‘moving backwards’
The retailer does not expect any impact from the drop in sterling since the Brexit vote to kick in until at least the spring of 2017, as it had hedged some of its foreign-currency exposures in advance. Still, it expects expenses to rise by up to 5 per cent next year. `The last time we had to increase prices (which was in 2010 when cotton prices soared) we estimated that price elasticity was around 1.1.’
If that remains the case today, a retail selling price increase of 5% would result in a fall in unit sales of -5.5% and a fall in like for like sales value of between -0.5% to -1.0%. In the scheme of things, we think that this drag on sales is manageable and less damaging than taking a significant hit to margin.’
Properties of price elasticity of demand:
| \(e_{Q,p}\) | \(abs(e_{Q,p})\) | Term |
|---|---|---|
| \(< -1\) | \(>1\) | Elastic |
| \(= -1\) | \(=1\) | Unit Elastic |
| \(> -1\) | \(<1\) | Inelastic |
As \(e_{Q,p}\) tells you the pct change quantity for a small pct change in price:
| \(abs(e_{Q,p})\) | Term | p rise \(\rightarrow\) expdr | p falls \(\rightarrow\) expdr |
|---|---|---|---|
| \(>1\) | Elastic | Falls bc Q falls more | Rises |
| \(=1\) | Unit Elastic | Constant | Constant |
| \(<1\) | Inelastic | Rises bc Q falls less | Falls |
\[e_{Q_d,I} = \frac{percent \ change \ in \ Q_d}{percent \ change \ in \ I} \] \[ = \frac{\Delta Q_d}{Q_d}/\frac{\Delta I}{I}\]
Normal goods: \(e_{Q,I} > 0\)
Inferior goods: \(e_{Q,I} < 0\)
Luxury goods: \(e_{Q,I} > 1\)
Prof. Muellbauer letter to FTo
Sir, Professor Gordon Gemmill (Letters, December 14), surprisingly for a trained economist, assumes an income elasticity of demand of zero for housing: that is, that people do not demand more and better housing as they become richer. Nowhere in the world is this the case! My own empirical work demonstrates that around two-thirds of the rise in UK house prices, corrected for general inflation, since 1980 is because supply is not keeping up with income and population growth.
Other drivers do exist … The price effects of extra supply take time to build up. I agree on that. But just imagine what would happen if we did nothing more than we are now doing: population and income growth would drive prices even higher even though we already hold the record for rises in house prices since 1970 among the group of seven leading high-income countries. We need to build far more housing, in the right locations. And we need to start now. - Prof John Muellbauer Nuffield College, Oxford, UK
Read on your own:
Cross-price elasticity of demand (read on your own)
Some elasticity estimates (note these are a bit dated)
Does this make sense??
Our company is very good at motivating our employees. We get twice as much production for each pound we spend on salaries as for each pound we spend on better machines; and we continue to invest in both.
???
We need to keep producing this product, even though it’s unpopular, because it cost us £1 million to develop, and we need to make this back.
???
My business is making a profit, even though I could have earned more money putting the £1,000,000 in a savings bond.
???